Financial due diligence is the process through which a potential acquirer, investor, or merger partner examines the financial records and reporting of your business before completing a transaction. The experience of going through due diligence varies enormously depending on how prepared the finance function is.
For a well-prepared company, due diligence is an intensive but manageable process: the information is organised, the numbers reconcile, and the team can answer questions quickly and confidently. For an unprepared company, due diligence is months of disruption, restatements, uncomfortable discoveries, and, in the worst cases, a price reduction or a deal that falls apart.
The difference is preparation. Most of what makes due diligence painful is not the existence of problems. It is the absence of organised information. This article covers what due diligence teams ask for, what clean books look like, and what to fix before the process begins.
What Due Diligence Actually Examines
Financial due diligence is not an audit. An audit verifies that the statutory accounts comply with accounting standards. Due diligence goes further: it examines the quality of earnings (are the profits real and recurring?), the sustainability of the financial model (will the results hold after the transaction?), and the financial risks that are not fully visible in the statutory accounts.
The questions that due diligence teams focus on most intensively are:
Is the reported revenue real and recurring? Due diligence will examine the revenue recognition policies, the customer concentration, the contract structure, and the evidence of historical collection. A business that recognises revenue aggressively, has significant customer concentration, or has lumpy non-recurring revenue components will face close scrutiny on the sustainability of its top line.
Are the reported costs complete? Due diligence will look for costs that are understated in the management accounts: related party transactions at below-market rates, costs that have been capitalised that should have been expensed, and one-time costs that recur. The normalised cost base, not the reported one, is what the buyer is paying for.
What are the off-balance-sheet commitments? Operating leases under OR that are not capitalised, guarantees, contingent liabilities, and pension obligations that are not fully funded all create financial exposure that does not appear prominently in the standard accounts.
What is the working capital position and its normalcy? Buyers of businesses typically negotiate the working capital included in the transaction on the basis of a “normalised” working capital calculation. A business that has been managing its working capital aggressively in the months before the transaction, collecting receivables faster than normal and deferring payables, will face a working capital adjustment at completion.
The Information Pack: What to Have Ready
Most due diligence processes begin with a data room: a structured, secure file repository containing the financial and legal information the due diligence team needs. Building the data room before the process begins, rather than assembling it reactively as requests come in, reduces the disruption to the business and signals to the buyer that the company is professionally managed.
Financial statements: Three years of signed statutory accounts (Jahresrechnung), including the audit report if applicable. Current year management accounts to the most recent month-end, in the same format as prior years. A schedule reconciling management accounts to statutory accounts for each year, explaining any differences in methodology.
Budget and forecasting: The current year budget with the assumptions behind the revenue and key cost lines. The prior year budget and a comparison of budget versus actual with explanations of significant variances. The current re-forecast if a mid-year update has been done.
Revenue analysis: A revenue breakdown by customer, by product line, or by geography (depending on relevance) for the last three years. The top 10 customers by revenue, with the revenue amount, the contract structure, and the contract expiry date for each. Renewal rates for recurring revenue. Any revenue that is one-time or non-recurring, clearly identified.
Cost structure: A detailed breakdown of operating costs by category for the last three years, with commentary on any significant changes. The headcount by function and the total fully loaded cost per FTE. Details of any related party transactions (sales to or purchases from shareholders, directors, or their connected entities).
Working capital: A month-by-month working capital schedule for the last 12 months showing receivables, payables, and inventory (if applicable). An explanation of any material movements.
Debt and obligations: A full schedule of all financial debt: outstanding balance, interest rate, maturity date, covenants, and whether the debt is repayable on change of control. All operating lease commitments. Guarantees provided or received.
Tax: Last three years of filed tax returns (direct federal tax and cantonal tax). Any open tax disputes or queries from the ESTV or cantonal tax authorities. MWST filings for the last three years.
The Ten Things to Fix Before Due Diligence Starts
1. Reconcile management accounts to statutory accounts. If there are unexplained differences between the management P&L and the statutory P&L, resolve them before a due diligence team finds them. Unexplained reconciling items create doubt about the reliability of both.
2. Document the revenue recognition policy. Write down, clearly and specifically, how and when revenue is recognised in different types of transactions. A policy that exists only in the controller’s head is a due diligence risk.
3. Identify and label non-recurring items. Any cost or revenue item that is one-time, unusual, or not expected to recur should be identified and documented before the due diligence team arrives and draws their own conclusions about what is non-recurring.
4. Clean up the related party transaction schedule. All transactions with shareholders, directors, and connected entities should be fully documented and confirmed to be at market rates, or explicitly disclosed as being at non-market rates with the difference quantified.
5. Resolve old balance sheet items. Provisions that have been on the balance sheet for more than 18 months without movement, receivables that are significantly overdue without active collection activity, and accruals that no longer correspond to a real obligation should all be reviewed and resolved.
6. Prepare a normalised EBITDA bridge. Starting from reported EBITDA, add back non-recurring costs, remove non-recurring revenue, adjust for any related party costs at below-market rates, and arrive at a normalised EBITDA figure. This is the number a buyer will use as the basis for the valuation multiple. Preparing it yourself, with clear documentation, is far better than letting the buyer’s team prepare it from first principles.
7. Organise contracts. Key customer contracts, supplier contracts, and lease agreements should be in a single organised location. Missing contracts create uncertainty about the rights and obligations that transfer with the business.
8. Prepare the working capital analysis. Calculate the average working capital over the last 12 months, month by month. Understand the seasonal pattern. Be prepared to discuss what “normalised” working capital is and why.
9. Check for undisclosed liabilities. Speak to the legal team about any pending or threatened litigation, regulatory proceedings, or tax disputes that have not been reflected in the accounts. Undisclosed liabilities discovered during due diligence are one of the most common causes of price reductions.
10. Get the data room populated early. A data room that is 80 percent complete at the start of the process signals readiness and reduces the disruption of answering ad hoc information requests throughout.
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Alessandro Ratzenberger is a fractional CFO and business controller based in Zurich, with 15 years of operational finance experience at Dufry Group and Bomi (UPS Group).
